Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a great way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.
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Many investors, veteran and amateur, have tried and failed.
The ups and downs of the market can be too unpredictable for anyone, especially the budding investor, to follow.
Dollar cost averaging may be an appealing strategy to new investors who are uncertain with the vagaries of the market or who don’t have substantial capital to deploy towards certain stocks.
This investing strategy is even used for 401(k) accounts and superannuation funds to help retirees enjoy their savings.
To put it simply, dollar cost averaging is an investment strategy where you buy a fixed currency amount of shares every day, week or month regardless of fluctuations in share prices.
It allows investors to mitigate downside risk and cultivates a sense of discipline required to build long term wealth.
So, how does Dollar Cost Averaging work?
The method is easy; for one to practice dollar cost averaging, they have to buy a stock in regular intervals using the same amount of currency.
In the table below, we will use $100 as the currency amount and use it to buy a stock called “Gracious Gold.”
In this scenario, we choose to buy $100 worth of Gracious Gold every month from January until May, a total of 5 investments, making the total amount invested $500
By dollar cost averaging here, we have purchased 104.91 shares of Gracious Gold. Now let’s invest the same amount but this time as a lump sum in the month of January. That’s one $500 investment with no shares bought in any month after January.
By buying a lump sum amount of shares in January, we’ve secured 100 shares of Gracious Gold, a smaller amount than what we got by dollar cost averaging.
If you sold the shares now, you would have made a neat profit of 4.91% by following this simple strategy.
What are the caveats to this strategy?
This strategy does not always work. If your stock is on a downward trend, dollar cost averaging will help you reduce your losses but will not help you get your money back.
If the stock is a loser, you will lose money either way regardless of whether you choose lump sum investing or dollar cost averaging.
The only difference is in how fast you lose money.
The second issue is obvious if you look at dollar cost averaging from the perspective of wanting to make big wins.
It stops you from making large gains on your stock if it does go up because you’re buying shares at intervals.
This means you’re buying more expensive stock each time, thereby limiting your gains.
Dollar cost averaging can help new investors ride out the market in a way that’s not jarring. If you’re just starting out in investing, be sure to give this time tested strategy a try.
This article is sourced from the following links:
What Is Dollar Cost Averaging? | Charles Schwab
What Is Dollar-Cost Averaging? (investopedia.com)
